UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
-----------
Commission File Number 0-21174
AVID TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2977748
(State or other jurisdiction of (I.R.S. Employer
inorporation or organization) Identification No.)
AVID TECHNOLOGY PARK
ONE PARK WEST
TEWKSBURY, MA 01876
(Address of principal executive offices)
Registrant's telephone number, including area code: (978) 640-6789
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
---- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
---- -----
The number of shares outstanding of the registrant's Common Stock as of October
20, 2004 was 33,958,648.
AVID TECHNOLOGY, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements:
a) Condensed Consolidated Statements of Operations (unaudited)
for the three and nine months ended September 30, 2004 and 2003 ........1
b) Condensed Consolidated Balance Sheets (unaudited) as of September 30, 2004
and December 31, 2003...................................................2
c) Condensed Consolidated Statements of Cash Flows (unaudited)
for the nine months ended September 30, 2004 and 2003 ..................3
d) Notes to Condensed Consolidated Financial Statements (unaudited)........4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................13
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk..........26
ITEM 4. Controls and Procedures............................................27
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings..................................................28
ITEM 6. Exhibits...........................................................28
SIGNATURES....................................................................30
EXHIBIT INDEX.................................................................31
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- --------------------------
2004 2003 2004 2003
------------- ------------- --------------------------
Net revenues $147,374 $119,090 $414,634 $344,584
Cost of revenues 62,845 52,784 177,943 155,619
Amortization of intangible assets 127 - 127 -
------------- ------------- --------------------------
Gross profit 84,402 66,306 236,564 188,965
------------- ------------- --------------------------
Operating expenses:
Research and development 23,780 20,706 68,996 63,833
Marketing and selling 33,435 27,959 96,945 80,971
General and administrative 7,386 5,670 19,456 16,632
Stock-based compensation * 553 - 553 -
Restructuring and other costs, net - 76 - 1,859
Amortization of intangible assets 988 341 1,976 975
------------- ------------- ------------ ------------
Total operating expenses 66,142 54,752 187,926 164,270
------------- ------------- ------------ ------------
Operating income 18,260 11,554 48,638 24,695
Other income, net 651 592 686 1,330
------------- ------------- ------------ ------------
Income before income taxes 18,911 12,146 49,324 26,025
Provision for (benefit from) income taxes (63) 300 137 900
------------- ------------- ------------ -----------
Net income $18,974 $11,846 $49,187 $25,125
============= ============= ============ ============
Net income per common share - basic $0.58 $0.40 $1.54 $0.88
Net income per common share - diluted $0.54 $0.35 $1.43 $0.78
Weighted average common shares outstanding - basic 32,737 29,865 31,857 28,663
Weighted average common shares outstanding - diluted 35,033 33,380 34,374 32,059
* Stock-based compensation associated with the acquisition of M-Audio (Note 3)
is comprised of $99 of research and development expense, $154 of marketing
and selling expense and $300 of general and administrative expense for the
three and nine months ended September 30, 2004.
The accompanying notes are an integral part of the condensed consolidated
financial statements.
1
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands) September 30, December 31,
(unaudited) 2004 2003
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $41,734 $102,649
Marketable securities 78,348 93,660
Accounts receivable, net of allowances of $9,193 and $9,161
at September 30, 2004 and December 31, 2003, respectively 94,438 69,230
Inventories 54,913 38,292
Current deferred tax assets, net 1,047 1,032
Prepaid expenses 7,295 5,117
Other current assets 5,610 7,032
---------------- ----------------
Total current assets 283,385 317,012
Property and equipment, net 26,558 23,223
Intangible assets, net 50,017 1,815
Goodwill 165,356 3,335
Long-term deferred tax assets, net 2,557 -
Other assets 3,804 2,734
---------------- ----------------
Total assets $531,677 $348,119
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $26,214 $15,755
Accrued compensation and benefits 22,400 23,753
Accrued expenses and other current liabilities 36,772 27,452
Income taxes payable 10,396 8,504
Deferred revenues 52,615 44,943
---------------- ----------------
Total current liabilities 148,397 120,407
Long-term debt and other liabilities 1,818 607
---------------- ----------------
Total liabilities 150,215 121,014
---------------- ----------------
Contingencies (Note 6)
Stockholders' equity:
Common stock 339 311
Additional paid-in capital 530,170 419,981
Accumulated deficit (145,288) (194,476)
Deferred compensation (4,947) (30)
Cumulative translation adjustment 1,381 1,306
Net unrealized gains (losses) on debt securities (193) 13
---------------- ----------------
Total stockholders' equity 381,462 227,105
---------------- ----------------
Total liabilities and stockholders' equity $531,677 $348,119
================ ================
The accompanying notes are an integral part of the condensed consolidated
financial statements.
2
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands - unaudited)
Nine Months Ended
September 30,
-----------------------------
2004 2003
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $49,187 $25,125
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 10,931 9,343
Provision for doubtful accounts and recourse obligations 91 418
Compensation expense from stock grants and options 583 169
Equity in income of non-consolidated company (85) (155)
Changes in operating assets and liabilities:
Accounts receivable (14,281) 5,869
Inventories (715) (515)
Prepaid expenses and other current assets 956 84
Accounts payable 3,774 (7,627)
Income taxes payable 1,156 610
Accrued expenses, compensation and benefits 2,236 742
Deferred revenues and deposits 3,301 6,637
- -----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 57,134 40,700
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (9,805) (4,578)
Payments for other long-term assets (485) (360)
Dividend from non-consolidated company - 85
Payments for business acquisitions, net of cash acquired (135,205) (409)
Purchases of marketable securities (29,938) (59,181)
Proceeds from sales of marketable securities 45,585 11,347
- -----------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (129,848) (53,096)
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations (492) (463)
Proceeds from issuance of common stock under employee stock plans 13,215 44,887
- -----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 12,723 44,424
- -----------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (924) 174
- -----------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (60,915) 32,202
Cash and cash equivalents at beginning of period 102,649 62,174
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $41,734 $94,376
- -----------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
PART I. FINANCIAL INFORMATION
ITEM 1D. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. FINANCIAL INFORMATION
The accompanying condensed consolidated financial statements include the
accounts of Avid Technology, Inc. and its wholly-owned subsidiaries
(collectively, "Avid" or the "Company"). These financial statements are
unaudited. However, in the opinion of management, the condensed consolidated
financial statements include all adjustments, consisting of only normal,
recurring adjustments, necessary for their fair presentation. Interim results
are not necessarily indicative of results expected for a full year. The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the instructions for Form 10-Q and therefore do not
include all information and footnotes necessary for a complete presentation of
operations, financial position, and cash flows of the Company, in conformity
with generally accepted accounting principles. The accompanying condensed
consolidated balance sheet as of December 31, 2003 was derived from Avid's
audited consolidated financial statements, but does not include all disclosures
required by generally accepted accounting principles. The Company filed audited
consolidated financial statements for the year ended December 31, 2003 in its
2003 Annual Report on Form 10-K, which included all information and footnotes
necessary for such presentation; the financial statements contained in this Form
10-Q should be read in conjunction with the audited consolidated financial
statements in the Form 10-K.
The Company's preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of revenues and
expenses during the reported periods. The most significant estimates reflected
in these financial statements include accounts receivable and sales allowances,
inventory valuation and income tax asset valuation allowances. Actual results
could differ from those estimates.
2. NET INCOME PER COMMON SHARE
Basic and diluted net income per share were as follows (in thousands, except per
share data):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- --------------------------
2004 2003 2004 2003
------------- ------------- ------------ ------------
Net income $18,974 $11,846 $49,187 $25,125
============= ============= ============ ============
Weighted average common shares outstanding - basic 32,737 29,865 31,857 28,663
Weighted average potential common stock:
Options 2,296 3,515 2,517 3,396
------------- ------------- ------------ ------------
Weighted average common shares outstanding - diluted 35,033 33,380 34,374 32,059
============= ============= ============ ============
Net income per common share - basic $0.58 $0.40 $1.54 $0.88
Net income per common share - diluted $0.54 $0.35 $1.43 $0.78
For the three and nine months ended September 30, 2004 and 2003, certain stock
options and a warrant have been excluded from the diluted net income per share
calculation. Their effect would be anti-dilutive since their exercise prices
were in excess of the Company's average common stock fair value for the related
period.
4
Common stock options and a warrant that were considered anti-dilutive securities
and excluded from the diluted net income per share calculations were as follows,
on a weighted-average basis:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------- ------------ ------------- ------------
Options 242 10 191 102
Warrant 1,155 1,155 1,155 1,155
------------- ------------ ------------- ------------
Total anti-dilutive common stock options and warrant 1,397 1,165 1,346 1,257
============= ============ ============= ============
3. ACQUISITIONS
M-Audio
In August 2004, Avid completed the acquisition of M-Audio, a leading provider of
digital audio and MIDI (Music Industry Digital Interface) solutions for
electronic musicians and audio professionals. Avid paid cash of $79.6 million
net of cash acquired of which $0.5 million will be paid out over a two year
period, and issued stock and options with a fair value of $96.5 million. The
market price of $42.72 used to value the Avid shares was based on the five-day
average closing price of the stock during the period beginning two days before
and ending two days after the date that the terms of the acquisition were agreed
to and announced publicly. The weighted average price of $35.14 used to value
the options was based on the same five-day average, less the weighted average
strike price of the options. Avid also incurred $3.3 million of transaction
costs. The Company has integrated M-Audio into its Professional Audio segment
and will market its line of audio products alongside Digidesign's digital audio
workstations for the professional and home/hobbyist markets. The goodwill of
$122.0 million resulting from the purchase price allocation reflects the value
of the underlying enterprise as well as synergies that Avid expects to realize,
including incremental sales of Digidesign products. The following table
summarizes the estimated fair value of the assets acquired and liabilities
assumed at the date of acquisition (in thousands):
Accounts receivable $7,288
Inventories 13,420
Other current assets 903
Equipment and other long-term assets 1,520
Identifiable intangible assets:
Customer relationships 28,000
Trade name 4,700
Non-compete covenant 1,200
Developed technology 4,500
Goodwill 122,022
----------------
Total assets acquired 183,553
Accounts payable (4,626)
Other current liabilities (5,065)
Deferred compensation related to stock options issued 5,499
----------------
Net assets acquired $179,361
================
As part of the purchase agreement, Avid may be required to make additional
payments to the former shareholders and option holders of M-Audio of up to $45.0
million, contingent upon the operating results of M-Audio through December 31,
2005. These payments, if required, will be made through the issuance of
additional Avid shares. Any additional Avid shares issued to the former
shareholders of M-Audio will be recorded as additional purchase price allocated
to goodwill. Any additional Avid shares issued to former option holders of
M-Audio will be recorded as stock-based compensation.
The identifiable intangible assets are being amortized over their estimated
useful lives of twelve years for customer relationships, six years for the trade
name, four years for the developed technology and two years for the non-compete
covenant. Accumulated amortization of these intangible assets was $0.5 million
at September 30, 2004. Amortization of these intangible assets in the full year
ending December 31, 2004 is expected to be $1.8 million. The $122.0 million of
5
goodwill was assigned to the Company's Audio segment and will not be amortized,
in accordance with the requirements of Statement of Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets". This goodwill is not
deductible for tax purposes.
Avid Nordic AB
In September 2004, the Company acquired Avid Nordic AB, a Sweden-based reseller
of Avid products operating in the Nordic and Benelux regions of Europe, for cash
(net of cash acquired) of Euro 6.1 million ($7.4 million) plus transaction costs
of $0.3 million. The Company previously had no ownership interest in Avid
Nordic. The acquisition allows Avid to serve customers directly in this region.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed in the transaction (in thousands):
Accounts receivable $3,702
Inventory 2,516
Other current assets 589
Equipment and other long-term assets 671
Identifiable intangible asset 4,700
Goodwill 1,955
-----------
Total assets acquired 14,133
Accounts payable (2,571)
Other current liabilities (2,260)
Long-term deferred tax liability (1,645)
-----------
Net assets acquired $7,657
===========
The identifiable intangible asset represents customer relationships developed in
the region by Avid Nordic AB. This asset will be amortized over a five-year
period. Accumulated amortization of this asset was $0.1 million at September 30,
2004. Amortization for the full year ended December 31, 2004 is expected to be
$0.3 million. The goodwill of $2.0 million resulting from the purchase price
allocation reflects the value of the assembled workforce and existing
infrastructure in the region. This goodwill was assigned to The Video and Film
Editing and Effects ("Video") segment and will not be amortized in accordance
with the requirements of SFAS No. 142. This goodwill is not deductible for tax
purposes.
NXN SOFTWARE AG
In January 2004, Avid acquired Munich, Germany-based NXN Software AG ("NXN"), a
leading provider of asset and production management systems specifically
targeted for the entertainment and computer graphics industries, for cash of
Euro 35 million ($43.7 million)less cash acquired of $0.8 million. The Company
also incurred $1.3 million of transaction costs. The acquisition expands Avid's
offering in digital asset management by enabling the Company's film and video
post-production, broadcast, audio and 3D animation customers to leverage the
workflow capabilities of the NXN Alienbrain(R) product line. NXN is reported
within Video segment. The goodwill resulting from the purchase price allocation
reflects the synergies the Company hopes to realize by integrating the NXN
technology with its other products. The following table summarizes the estimated
fair value of the assets acquired and liabilities assumed at the date of
acquisition (in thousands):
Current assets $2,049
Equipment and other long-term assets 584
Identifiable intangible assets 7,200
Deferred tax assets, net 2,480
Goodwill 38,813
-----------
Total assets acquired 51,126
Current liabilities assumed (6,169)
-----------
Net assets acquired $44,957
===========
The identifiable intangible assets include completed technology valued at $4.3
million, customer relationships valued at $2.1 million, and a trade name valued
at $0.8 million, most of which are being amortized over a six-year period.
6
Amortization expense relating to these intangibles was $0.3 million and $0.9
million for the three- and nine-month periods ended September 30, 2004,
respectively. Amortization of these intangibles for the full year ended December
31, 2004 is expected to be $1.2 million. During the nine-month period ended
September 30, 2004, the $38.8 million of goodwill was reduced by $0.7 million to
$38.1 million due to a reduction in the estimated fair value of deferred revenue
acquired from NXN. This goodwill was assigned to the Video segment and, in
accordance with the requirements of SFAS No. 142, will not be amortized. This
goodwill is not deductible for tax purposes.
Pro Forma Financial Information for Acquisitions (Unaudited)
The results of operations of M-Audio, Avid Nordic and NXN have been included in
the results of operations of the Company since the respective date of each
acquisition. The following unaudited pro forma financial information presents
the results of operations for the three- and nine-month periods ended September
30, 2004 and 2003 as if the acquisitions of both M-Audio and NXN had occurred at
the beginning of 2003. The Company's pro forma results of operations giving
effect to the Avid Nordic AB acquisition as if it had occurred at the beginning
of 2003 is not included as it would not differ materially from the reported
results. The pro forma financial information for the combined entities has been
prepared for comparative purposes only and is not indicative of what actual
results would have been if the acquisitions had taken place at the beginning of
fiscal 2003, or of future results.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------- ------------- ------------
(In thousands, except per share data)
Net revenues $156,329 $133,273 $456,918 $384,739
Net income $18,416 $9,549 $46,828 $18,289
Net income per share:
Basic $0.54 $0.30 $1.40 $0.60
Diluted $0.51 $0.27 $1.30 $0.54
4. INVENTORIES
Inventories consisted of the following (in thousands):
September 30, December 31,
2004 2003
-------------------- --------------------
Raw materials $16,024 $12,086
Work in process 4,694 1,475
Finished goods 34,195 24,731
-------------------- --------------------
$54,913 $38,292
==================== ====================
As of September 30, 2004 and December 31, 2003, the finished goods inventory
included deferred costs of $8.0 million and $14.0 million, respectively,
associated with product shipped to customers for which revenue had not yet been
recognized.
5. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the intrinsic
value method as prescribed by Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, no compensation expense is recorded for options issued to employees
in fixed amounts and with fixed exercise prices at least equal to the fair
market value of the Company's common stock at the date of grant. When the
exercise price of stock options granted to employees is less than the fair
market value of common stock at the date of grant, the Company records that
difference multiplied by the number of shares under option as deferred
compensation, which is then amortized over the vesting period of the options.
Additionally, deferred compensation is recorded for restricted stock granted to
employees based on the fair market value of the Company's stock at date of grant
less the amount paid, if any, for the stock by the employee and is amortized
over the period during which the restrictions lapse. For holders of these
7
options or shares who are terminated, the Company ceases amortization and
reclassifies the associated deferred compensation to additional paid-in capital.
As part of the consideration for the purchase of M-Audio, the Company granted
approximately 345,000 options to employees and issued approximately 34,000
shares of restricted stock. In accordance with Financial Accounting Standards
Board Interpretation No. 44, a portion of the intrinsic value of the unvested
awards was recorded as deferred compensation and is being recognized as
stock-based compensation over the remaining future vesting period or, in the
case of the restricted stock, as the restrictions lapse.
The Company follows the disclosure-only provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," and SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," for employee awards. All stock-based
awards to non-employees are accounted for at their fair value in accordance with
SFAS No. 123.
The following table illustrates the effect on net income and net income per
share as if the Company had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee awards (in thousands, except per share
data).
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
Net income as reported $18,974 $11,846 $49,187 $25,125
Add: Stock-based employee compensation expense included
in reported net income 557 35 583 64
Deduct: Total stock-based employee compensation expense
determined under the fair value-based method for all
awards, net of related tax effects (4,346) (2,737) (11,657) (9,310)
----------- ----------- ----------- ----------
Pro forma net income $15,185 $9,144 $38,113 $15,879
=========== =========== =========== ==========
Net income per share:
Basic-as reported $0.58 $0.40 $1.54 $0.88
Basic-pro forma $0.46 $0.31 $1.20 $0.55
Diluted-as reported $0.54 $0.35 $1.43 $0.78
Diluted-pro forma $0.44 $0.28 $1.12 $0.50
Under SFAS No. 123, the fair value of each option grant is estimated on the date
of grant using the Black-Scholes option pricing model and is amortized over the
stock option's vesting period.
6. CONTINGENCIES
On March 11, 1996, Avid was named as a defendant in a patent infringement suit
filed in the United States District Court for the Western District of Texas by
Combined Logic Company, a California partnership located in Beverly Hills,
California. On May 16, 1996, upon Avid's motion, the suit was transferred to the
United States District Court for the Southern District of New York. The
complaint alleges infringement by Avid of U.S. patent number 4,258,385, and
seeks injunctive relief, treble damages, costs, and attorneys' fees. This patent
expired on May 15, 1999 and therefore, would not be applicable to the products
currently offered by Avid. Accordingly, potential damages, if any, are limited
to the period beginning March 11, 1990 (six years prior to this date of the
complaint) and ending May 15, 1999. In its answer to the complaint, the Company
asserted that it did not infringe the patent and that the patent is invalid.
Avid argued a Motion to Dismiss this claim on November 5, 2004 and is awaiting
the decision of the court. The Company is unable to quantify a range of loss
in this litigation. Combined Logic Company did not specify an alleged damage
amount in its complaint. As only limited discovery has been conducted to date
by either side in the eight years since Combined Logic Company filed its
complaint, the Company believes it does not have sufficient information to
provide any meaningful estimate of the possible range of damages that Combined
Logic Company might seek. The Company believes it has meritorious defenses to
the complaint and intends to contest it vigorously. However, an adverse
resolution of this litigation could have an adverse effect on the Company's
8
consolidated financial position or results of operations in the period in which
the litigation is resolved. No costs have been accrued for this possible loss
contingency.
In March 1999, Avid and Tektronix, Inc. were sued by Glen Holly Entertainment,
Inc., a Tektronix distributor, claiming that Tektronix's discontinuance of the
Tektronix Lightworks product line was the result of a strategic alliance by
Tektronix and Avid. Glen Holly raised antitrust and common law claims against
Avid and Tektronix, and sought lost future profits, treble damages, attorneys'
fees, and interest. In March 2001, the United States District Court for the
District of California dismissed the anti-trust claims against both parties and
the remaining common law claim against the Company was dismissed by stipulation
and court order on April 6, 2001. Glen Holly subsequently appealed the lower
court's decision. On September 9, 2003, a three-judge panel of the U.S. Court of
Appeals for the Ninth Circuit reversed in part the lower court's dismissal and
sent the antitrust claims back to the lower court for further findings. Avid and
Tektronix filed a Petition for a rehearing by the three-judge panel and a
rehearing by the full Ninth Circuit on September 23, 2003. The Petition was
denied on December 12, 2003. On March 18, 2004, the Company entered into a
settlement agreement with Glen Holly whereby each party issued a general release
of all claims relating to the allegations made in this lawsuit. In consideration
of the settlement, Avid agreed to make a payment to Glen Holly of $1,050,000 and
accordingly, $985,000 was paid in March 2004 and the remaining $65,000 was paid
in April 2004. On March 19, 2004, Avid filed an application for determination of
good faith settlement with the U.S. District Court requesting that it determine
whether Tektronix had a right to contribution or indemnification from Avid
arising from claims asserted in the lawsuit. On June 17, 2004, the U.S. District
Court issued a ruling in which it determined that Tektronix had no such right.
On June 24, 2004, Glen Holly filed a stipulation of dismissal with the Court,
dismissing all claims alleged against the Company in this proceeding. On July
14, 2004, the court issued an order finding that the settlement agreement
between Avid and Glen Holly was entered into in good faith under applicable law.
Avid receives inquiries from time to time with regard to possible patent
infringement claims. If any infringement is determined to exist, the Company may
seek licenses or settlements. In addition, as a normal incidence of the nature
of the Company's business, various claims, charges, and litigation have been
asserted or commenced against the Company arising from or related to contractual
or employee relations, intellectual property rights or product performance.
Management does not believe these claims will have a material adverse effect on
the financial position or results of operations of the Company.
From time to time, the Company provides indemnification provisions in agreements
with customers covering potential claims by third parties that Avid products
infringe their intellectual property rights. Pursuant to these indemnification
provisions, the Company agrees to indemnify customers for losses that they
suffer or incur in connection with any valid U.S. patent or copyright
infringement claim brought by a third party with respect to Avid products. These
indemnification provisions generally offer perpetual coverage for infringement
claims based upon the products covered by the agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is theoretically unlimited; however, to date, the
Company has not received any claims under these indemnification provisions. As a
result, the Company believes the estimated fair value of these indemnification
provisions is minimal.
The Company has a standby letter of credit at a bank that is used as a security
deposit in connection with the Company's Daly City, California office space
lease. In the event of default on this lease, the landlord would be eligible to
draw against this letter of credit to a maximum as of September 30, 2004 of $4.3
million, subject to an annual reduction of approximately $0.8 million but not
below $2.0 million. The letter of credit will remain in effect at $2.0 million
throughout the remaining lease period, which extends to September 2009. As of
September 30, 2004, the Company was not in default of this lease.
The Company, through a third party, provides lease financing options to its
customers, including primarily end-users, and occasionally distributors. During
the terms of these leases, which are generally three years, the Company remains
liable for any unpaid principal balance upon default by the end-user, but such
liability is limited in the aggregate based on a percentage of initial amounts
funded or, in certain cases, amounts of unpaid balances. At September 30, 2004
and December 31, 2003, Avid's maximum recourse exposure totaled approximately
$16.6 million and $14.8 million, respectively. The Company records revenue from
these transactions upon the shipment of products, provided that all other
revenue recognition criteria are met. Because the Company has been providing
these financing options to its customers for many years, the Company has a
substantial history of collecting under these arrangements without providing
refunds or concessions to the end user or financing party. To date, the payment
default rate has consistently been between 2% and 4% per year. The Company
maintains a reserve against the entire portfolio balance, approximately $52.0
9
million and $63.5 million at September 30, 2004 and December 31, 2003,
respectively for estimated losses under this recourse lease program based on
these historical default rates. At September 30, 2004 and December 31, 2003, the
Company's accrual for estimated losses was $2.4 million and $3.3 million,
respectively.
Avid provides warranty on hardware sold through its Video segment which
generally mirrors the manufacturers' warranties. The Company charges the related
material, labor and freight expense to cost of revenues in the period incurred.
With respect to the Audio business, Avid provides warranty on externally sourced
and internally developed hardware and records an accrual for the related
liability based on historical trends and actual material and labor costs. The
warranty period for all of the Company's products is generally 90 days to one
year but can extend up to five years depending on the manufacturer's warranty.
The following table sets forth the activity in the product warranty accrual
account (in thousands):
Nine Months Ended September 30,
2004 2003
----------------- ----------------
Accrual balance at beginning of period $1,355 $922
Accruals for product warranties 2,651 1,813
Cost of warranty claims (1,894) (1,511)
----------------- ----------------
Accrual balance at end of period $2,112 $1,224
================= ================
7. COMPREHENSIVE INCOME
Total comprehensive income net of taxes consists of net income, the net changes
in foreign currency translation adjustment and net unrealized gains and losses
on available-for-sale securities. The following is a summary of the Company's
comprehensive income, (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
2004 2003 2004 2003
------------- ------------- -------------- -------------
Net income $18,974 $11,846 $49,187 $25,125
Net changes in:
Foreign currency translation adjustment 1,459 436 75 3,675
Unrealized gains (losses) on securities 99 (6) (206) 40
------------- ------------- -------------- -------------
Total comprehensive income $20,532 $12,276 $49,056 $28,840
============= ============= ============== =============
8. SEGMENT INFORMATION
The Company's organizational structure is based on strategic business units that
offer various products to the principal markets in which the Company's products
are sold. These business units equate to two reportable segments: Video and Film
Editing and Effects, and Professional Audio. The following is a summary of the
Company's operations by reportable segment (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ----------------------------
2004 2003 2004 2003
--------------- ------------- -------------- -----------
Video and Film Editing and Effects:
Net revenues $95,605 $86,689 $284,015 $243,420
Operating income $11,395 $9,746 $32,706 $17,574
Professional Audio:
Net revenues $51,769 $32,401 $130,619 $101,164
Operating income $8,533 $2,225 $18,588 $9,955
Combined Segments:
Net revenues $147,374 $119,090 $414,634 $344,584
Operating income $19,928 $11,971 $51,294 $27,529
10
The following table reconciles operating income for reportable segments to the
total consolidated amounts for the three- and nine-month periods ended September
30, 2004 and 2003 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
2004 2003 2004 2003
------------- ------------- -------------- -------------
Total operating income for reportable segments $19,928 $11,971 $51,294 $27,529
Unallocated amounts:
Restructuring and other costs, net - (76) - (1,859)
Stock-based compensation (553) - (553) -
Amortization of acquisition-related intangible
assets (1,115) (341) (2,103) (975)
------------- ------------- -------------- -------------
Consolidated operating income $18,260 $11,554 $48,638 $24,695
============= ============= ============== =============
9. RESTRUCTURING AND OTHER COSTS, NET
In December 2002, the Company recorded a charge of $3.3 million in connection
with vacating excess space in its Tewksbury, Massachusetts; Daly City,
California; and Montreal, Canada facilities. The portion of the charge related
to Tewksbury ($0.5 million) resulted from a revision of the Company's estimate
of the timing and amount of future sublease income associated with that
facility, for which a charge had previously been included in a 2001
restructuring. The remaining portion of the charge for Daly City and Montreal
was a result of the Company's ceasing to use a portion of each facility in
December 2002, and hiring real estate brokers to assist in finding subtenants.
The Daly City estimate was revised, and an additional charge recorded, in the
fourth quarter of 2003.
In March 2003, the Company implemented a restructuring program under which 48
employees worldwide were terminated, and a leased facility in California was
vacated. In connection with these actions, the Company recorded a charge of $1.2
million for employee terminations and $0.6 million for unutilized space in Santa
Monica that included a write-off of leasehold improvements of $0.4 million. In
September 2004, Avid recorded a charge of $0.2 million to reflect the decrease
in rent to be received from one of the Company's subtenants and reversed a
charge of $0.2 million associated with unutilized space in Tewksbury.
The Company recorded the December 2002 and March 2003 charges in accordance with
the guidance of SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities". SFAS No. 146 requires that a liability be recognized for
an operating lease that is not terminated based on the remaining lease rental
costs, measured at its fair value on a discounted cash flow basis, when the
entity ceases using the rights conveyed by the operating lease. That amount is
reduced by any estimated potential sublease rentals, regardless of whether the
entity intends to enter into a sublease. Future changes in the fair value of the
Company's obligations are recorded through operating expenses.
The following table sets forth the activity in the restructuring and other costs
accrual, which is included in Accrued expenses and other liabilities for the
nine months ended September 30, 2004 (in thousands):
Employee Facilities
Related Related Total
-------------- -------------- --------------
Accrual balance at December 31, 2003 $50 $4,843 $4,893
Revisions of estimated liabilities (50) 50 -
Cash payments - (1,130) (1,130)
-------------- -------------- --------------
Accrual balance at September 30, 2004 $- $3,763 $3,763
============== ============== ==============
The majority of the facilities-related accrual represents estimated losses on
subleases of space vacated as part of the Company's restructuring actions. The
leases, and charges against the amount accrued, extend through 2010 unless the
Company is able to negotiate an earlier termination.
11
10. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain Financial
Instruments with Characteristics of Both Liabilities and Equity", which
establishes standards for how an issuer of financial instruments classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) if, at
inception, the monetary value of the obligation is based solely or predominantly
on a fixed monetary amount known at inception, variations in something other
than the fair value of the issuer's equity shares or variations inversely
related to changes in the fair value of the issuer's equity shares. This
Statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. On November 7, 2003, the FASB deferred the
classification and measurement provisions of SFAS No. 150 as they apply to
certain mandatory redeemable non-controlling interests. This deferral is
expected to remain in effect while these provisions are further evaluated by the
FASB. The Company has not entered into or modified any financial instruments
covered by this statement after May 31, 2003 and the application of this
standard is not expected to have a material impact on the Company's financial
position or results of operations.
On October 13, 2004, the FASB concluded that Statement of Financial Accounting
Standards No. 123R, "Share-Based Payment" ("Statement 123R"), which would
require all companies to measure compensation cost for all share-based payments
(including employee stock options) at fair value, would be effective for public
companies (except small business issuer as defined in SEC Regulation S-B) for
interim or annual periods beginning after June 15, 2005. Retroactive application
of the requirements of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," ("Statement 123"), not Statement
123R, to the beginning of the fiscal year that includes the effective date would
be permitted, but not required. Note 5 - "Accounting for Stock Based
Compensation" sets forth the pro forma effect on net income and earnings per
share assuming Avid had applied the fair value recognition provisions of
Statement 123. The retroactive provisions permitted under this conclusion will
not impact Avid since the first interim period that Statement 123R will be
effective for Avid will be the third quarter of 2005.
12
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
We develop, market, sell and support a wide range of software and
hardware for digital media production, management and distribution. Digital
media are video, audio or graphic elements in which the image, sound or picture
is recorded and stored as digital values, as opposed to analog, or tape-based,
signals. Our diverse range of product and service offerings enables customers
to "Make, Manage and Move Media."
Make Media. Our Video and Film Editing and Effects ("Video") segment
offers digital, non-linear video and film editing systems and 3D and special
effects software that enable users to manipulate moving pictures and sound in a
faster, easier, more creative, and more cost-effective manner than using
traditional analog tape-based systems. Non-linear systems allow editors to
access material instantaneously rather than requiring them to work sequentially.
Our Professional Audio ("Audio") segment, Digidesign, offers digital audio
software applications and hardware systems for music, film, television, video,
broadcast, streaming media, and web development. These systems are based upon
proprietary Digidesign/Avid audio hardware, software, and control surfaces, and
allow users to record, edit, mix, process, and master audio in an integrated
manner.
Manage Media. We provide complete network, storage, and database
solutions based on our Avid Unity MediaNetwork technology. This technology
enables users to simultaneously share and manage media assets throughout a
project or organization. The ability to effectively manage digital media assets
is a critical component of success for many broadcast and media companies with
multiple nonlinear editing workstations in a range of geographic locations. As a
result, professionals can collaborate seamlessly on all production elements, and
streamline the process for cost-effectively delivering compelling media
experiences and quickly "re-purposing" or finding new uses or markets for media
assets.
Move Media. We offer products that allow our customers to distribute
media over multiple platforms - including air, cable or satellite, or through
the Internet. In addition, we provide technology for playback directly to air
for broadcast television applications. Many of our products also support the
broadcast of streaming Internet video.
Our products are used worldwide in production and post-production
facilities; film studios; network, affiliate, independent and cable television
stations; recording studios; advertising agencies; government and educational
institutions; corporate communication departments; and game developers and
Internet professionals. Projects produced by our customers using our products
have been honored with Oscar(R), Emmy(R), and Grammy(R) awards, as well as a
host of other international awards. In addition, we have received numerous
awards for technical innovations, including Oscars, Emmys and a Grammy. (Oscar
is a registered trademark and service mark of the Academy of Motion Picture Arts
and Sciences. Emmy is a registered trademark of ATAS/NATAS. Grammy is a
registered trademark of The National Academy of Recording Arts and Sciences,
Inc.)
An important part of our strategy for the past few years has included
expanding and enhancing our product lines and increasing revenues through both
acquisitions and internal development of products. In January 2004, we acquired
Munich, Germany-based NXN Software AG ("NXN"), a leading provider of asset and
production management systems specifically targeted for the entertainment and
computer graphics industries. This acquisition expands Avid's offering in
digital asset management by enabling our film and video post-production,
broadcast, audio and 3D animation customers to leverage the workflow
capabilities of the NXN Alienbrain(R) product line. NXN has been integrated into
our Video segment. In August 2004, we completed the acquisition of Irwindale,
CA-based M-Audio, a leading provider of digital audio and MIDI solutions for
electronic musicians and audio professionals. We have integrated M-Audio into
our Audio segment as a business within our Digidesign audio division, and will
market its line of audio products alongside Digidesign's digital audio
workstations for the professional and home/hobbyist markets. Finally, in
September 2004, we acquired Avid Nordic AB, a Sweden-based reseller of Avid
products operating in the Nordic and Benelux regions of Europe. This acquisition
allows us to directly serve customers in this region.
In April 2004, we introduced two new audio control surfaces as part of
our Digidesign Pro Tools audio product line. D-Control is a high-end, expandable
control surface offering instant access to a large number of mixing parameters
while mixing or recording audio. Together with the Pro Tools|HD system,
D-Control is the basis of the ICON audio production system. Digidesign Command|8
is a semi-professional, small-format control surface which can be used with
13
Digidesign Pro Tools|HD, Pro Tools LE, and Avid Media Composer systems. Both
control surfaces include integrated, high-quality audio monitoring.
In June 2004, we introduced Avid Xpress Studio Complete and Avid Xpress
Studio Essentials, end-to-end content creation suites for DV professionals. Avid
Xpress Studio fully integrates Avid Xpress Pro video editing, Avid Pro Tools LE
audio production, Avid 3D animation, Avid FX compositing and titling, and Avid
DVD authoring software, and offers a choice of Digidesign Mbox or Digidesign 002
and Avid Mojo hardware for tactile audio control and expanded video I/O. Avid
Xpress Studio suites deliver best-of-breed software, hardware, and
interoperability at an affordable price.
Also introduced in June 2004, SOFTIMAGE|XSI(R) version 4.0 is the
latest release of the industry-leading non-linear 3-D production environment.
Version 4.0 delivers advanced toolsets, performance enhancements, and
significant advancements to the core architecture of the software, including new
customization, project management, and workgroup capabilities. To bring
Softimage's professional animation software to a wider audience, the new version
is available in three distinct configurations: XSI Advanced, XSI Essentials, and
the new entry-level, very affordable XSI Foundation.
In 2004, with the introduction of Avid DNxHD technology, we continued
to expand our technology leadership in combining high-quality video and
efficient file sizes. Avid DNxHD encoding delivers 8- and 10-bit
mastering-quality, high-definition (HD) images at bandwidths normally associated
with uncompressed, standard-definition (SD) media. High-efficiency Avid DNxHD
formats enable real-time HD collaboration using today's Avid Unity MediaNetwork
shared storage environments, supporting workflows for HD that postproduction and
broadcast professionals have come to expect for SD. Avid DNxHD technology made
its debut with the September 2004 release of Avid DS Nitris version 7.5,
expanding the capabilities of Avid's high-performance finishing and mastering
system.
In April 2003, we introduced a new family of products based on our
Digital Nonlinear Accelerator (Avid DNA) architecture: a powerful series of
computer hardware products engineered specifically for media processing. When
paired with our industry-leading nonlinear editing software, the Avid DNA family
enables professionals to achieve real-time functionality and superior image and
sound quality when capturing, editing, finishing, and outputting DV, SD, and HD
video formats. The Avid DNA family includes the Media Composer Adrenaline and
Avid NewsCutter Adrenaline FX systems, both of which began shipping in the
second quarter of 2003, and the Avid Xpress Pro and Avid Mojo software/hardware
tandem, which began shipping in the third quarter of 2003. The Avid Media
Composer Adrenaline system leverages the key features of its predecessors and
offers improved quality, speed, and performance in high-pressure, time-sensitive
television and film production environments. The Avid NewsCutter Adrenaline FX
system expands news editing capabilities by offering speed, reliability, and a
range of professional news-focused editing and workflow features in a turnkey
PC-based platform. Avid Xpress Pro software and Avid Mojo hardware deliver
professional video, film, and audio editing capabilities--including automatic
color correction and real-time digital and analog output, and are qualified to
run on a wide range of Windows-based CPUs as well as on the Power Mac G5
platform. The Avid DNA family also includes the Avid DS Nitris system, which
began shipping in the fourth quarter of 2003. The Avid DS Nitris product is a
powerful, high-resolution finishing workstation offering real-time effects and
color correction.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements and related disclosures in
conformity with U.S. generally accepted accounting principles and the Company's
discussion and analysis of its financial condition and results of operations
requires the Company's management to make judgments, assumptions, and estimates
that affect the amounts reported in its consolidated financial statements and
accompanying notes. Note 1 of the Notes to Consolidated Financial Statements in
the Company's 2003 Form 10-K describes the significant accounting policies and
methods used in the preparation of the Company's consolidated financial
statements. Management bases its estimates on historical experience and on
various other assumptions that it believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities. Actual results may differ from
these estimates.
Management believes the Company's critical accounting policies are
those related to revenue recognition and allowances for product returns and
exchanges, allowance for bad debts and reserves for recourse under financing
transactions, inventories and income taxes. Management believes these policies
to be critical because they are both important to the portrayal of the Company's
financial condition and results of operations, and they require management to
make judgments and estimates about matters that are inherently uncertain.
Additional information about these critical accounting policies may by found in
14
the Company's 2003 Form 10-K in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," under the heading "Critical
Accounting Policies and Estimates."
RESULTS OF OPERATIONS
Net Revenues
Our net revenues are derived mainly from the sales of computer-based
digital, nonlinear media editing systems and average selling prices include the
impact of price changes, discounting and mix (higher or lower-end) of products
sold. Average selling prices also include the impact of related peripherals,
licensing of related software, and sales of related software maintenance
contracts. This market has been, and we expect it to continue to be, highly
competitive. A significant portion of these revenues is generated by sales near
the end of each quarter, which can impact our ability to accurately forecast
revenues on a quarterly basis. Increasingly, revenues are also being derived
from sales of "solutions" encompassing multiple products and networking
capabilities that enable users to share and manage media throughout a project or
organization. Such solution sales may include training and installation
services, as well as workflow management assistance, to be provided by us or a
third party. Depending upon the complexity of the arrangement and the level of
our involvement, the revenues resulting from these solution sales may be
deferred for one or more quarters while the services are being performed.
Net revenues increased by $28.3 million (23.8%) to $147.4 million for
the quarter ended September 30, 2004 from $119.1 million for the same quarter in
2003. Revenues in our Video business increased $8.9 million or 10.3%, while
revenues in our Audio business grew by $19.4 million or 59.8%. The growth in the
Video business reflects increased sales volume of our products, specifically the
Avid DNA family of products released in the second through fourth quarters of
2003 as well as increased service revenues. Revenue growth in our Audio segment
primarily reflects increased sales volume of our products including the ProTools
TDM product family and products sold into the Pro Tools LE home/hobbyist market.
The Audio segment revenue increase also includes the impact of the acquisition
of M-Audio in the current quarter. Revenue growth in both segments was also
helped by higher average selling prices in 2004 as compared to 2003. Average
selling prices include the impact of price changes, discounting and mix (higher
or lower-end) of products sold. Average selling prices also include the impact
of related peripherals, licensing of related software, and sales of related
software maintenance contracts. Foreign currency exchange rate changes had a
favorable impact on both segments in 2004 compared to 2003.
Net revenues increased by $70.0 million (20.3%) to $414.6 million for
the nine months ended September 30, 2004 from $344.6 million for the nine months
ended September 30, 2003. Revenues in our Video business increased $40.6 million
or 16.7%, while revenues in our Audio business grew by $29.5 million or 29.1%.
The growth in both segments is due to the factors mentioned above.
Net revenues derived through indirect channels were approximately 69%
and 73% of net revenues for the quarters ended September 30, 2004 and 2003,
respectively. Indirect channel revenues were approximately 72% and 74% of net
revenues for the nine-month periods ended September 30, 2004 and 2003,
respectively. We generally sell directly to our broadcast customers and expect
this will be an area of potential revenue growth in the future.
Sales in the Americas (North and South America) have typically
accounted for approximately 55% of our consolidated net revenues, with sales in
Europe and Asia Pacific represent the remaining 45%. However, the relative
percentages of sales among the regions can vary based on, among other things,
the impact of currency exchange rate fluctuations on revenues, the timing of
revenue recognition of solutions sales, and local economic conditions.
Sales in the Americas accounted for 54% of our third quarter 2004 and
2003 net revenues. For the nine-month periods ended September 30, 2004 and 2003,
sales in the Americas accounted for 55% and 56% of net revenues, respectively.
For the three- and nine-month periods ended September 30, 2004, Americas sales
increased by approximately $15.0 million or 23.2% and $34.5 million or 18.0%,
respectively, compared to the same periods in 2003.
Sales in the Europe and Asia Pacific regions accounted for 46% of our
third quarter 2004 and 2003 net revenues. For the nine-month periods ended
September 30, 2004 and 2003, sales in the Europe and Asia Pacific regions
accounted for 45% and 44% of net revenues, respectively. For the three- and
nine-month periods ended September 30, 2004, Europe and Asia Pacific regions
sales increased by approximately $13.3 million or 24.4% and $35.6 million or
15
23.3%, respectively, compared to the same periods in 2003, with the impact of
currency translation being a favorable factor, particularly in Europe.
Gross Profit
Costs of revenues consists primarily of costs associated with the
procurement of components; post-sales customer support costs related to
maintenance contract revenue and other services; the assembly, testing, and
distribution of finished products; warehousing; and royalties for third-party
software included in our products. The resulting gross margin fluctuates based
on factors such as the mix of products sold, the cost and proportion of
third-party hardware and software included in the systems sold, the offering of
product upgrades, price discounts and other sales promotion programs, the
distribution channels through which products are sold, the timing of new product
introductions, sales of aftermarket hardware products such as disk drives, and
currency exchange rate fluctuations.
Our gross margin increased to 57.4% in the third quarter of 2004 from
55.7% for the same period of 2003. Margins in both segments improved with the
most significant factors being a favorable product mix in the Audio segment and
favorable overhead absorption in the Video segment due to higher revenue volume.
Additionally, there was a positive impact on revenue from currency exchange
rates with no material offsetting impact on costs of revenues as most of our
manufacturing costs are transacted in U.S. dollars.
Our gross margin increased to 57.1% for the nine months ended September
30, 2004 from 54.8% for the same period in 2003. Margins in both the Video and
Audio segments improved, with the most significant factors being due to the
factors mentioned above.
Research and Development
Research and development expenses increased by $3.1 million (14.8%) in
the third quarter of 2004 compared to the same period in 2003 and increased by
$5.2 million (8.1%) for the nine months ended September 30, 2004 compared to the
same period in 2003. The increase in the three-month period ended September 30,
2004 was primarily the result of personnel-related expenses (in part due to the
acquisitions of NXN and M-Audio), partially offset by decreased spending on
computer supplies and hardware for the development of new products. The increase
in the nine-month period ended September 30, 2004 was primarily the result of
personnel related expenses (in part due to the acquisition of NXN and to a
lesser extent M-Audio), partially offset by decreased fees associated with
outsourcing certain engineering activities. Research and development expenses
decreased to 16.1% of net revenues in the third quarter of 2004 compared to
17.4% in the same quarter of 2003 and decreased to 16.6% of net revenues for the
nine months ended September 30, 2004 from 18.5% for the same period in 2003 due
to the increased revenue base.
Marketing and Selling
Marketing and selling expenses increased by $5.5 million (19.6%) in the
third quarter of 2004 compared to the same period in 2003 and increased by $16.0
million (19.7%) for the nine months ended September 30, 2004 compared to the
same period in 2003. The increase in both periods was primarily the result of
personnel-related expenses (in part due to the acquisition of NXN and M-Audio),
trade show and other marketing programs and increased travel expenses. The
increase in the nine-month period ended September 30, 2004 also included higher
net foreign exchange losses (specifically, transaction and re-measurement gains
and losses on net monetary assets denominated in foreign currencies, offset by
hedging gains and losses), which are included in marketing and selling expenses.
Marketing and selling expenses decreased to 22.7% of net revenues in the third
quarter of 2004 compared to 23.5% in the same quarter of 2003 and decreased to
23.4% of net revenues for the nine months ended September 30, 2004 from 23.5%
for the same period in 2003 due to the increased revenue base.
General and Administrative
General and administrative expenses increased by $1.7 million (30.3%)
in the third quarter of 2004 compared to the same period in 2003 and increased
by $2.8 million (17.0%) for the nine months ended September 30, 2004 compared to
the same period in 2003. The increase in both 2004 periods was primarily due to
higher personnel-related costs and to higher audit fees related to compliance
with the Sarbanes-Oxley Act of 2002. General and administrative expenses
increased to 5.0% of net revenues in the third quarter of 2004 compared to 4.8%
in the same quarter of 2003 due to the factors mentioned above and decreased to
16
4.7% from 4.8% of net revenues for the nine-month period ended September 30,
2004 due to the increased revenue base.
Restructuring and Other Costs, Net
In March 2003, we implemented a restructuring program under which 48
employees worldwide were terminated, and a leased facility in California was
vacated. In connection with these actions, during the first three months of 2003
we recorded a charge of $1.2 million for employee terminations and $0.6 million
for unutilized space in Santa Monica that included a write-off of leasehold
improvements of $0.4 million.
Amortization of Acquisition-Related Intangible Assets
In August 2004, we acquired M-Audio, a leading provider of digital
audio and MIDI solutions for electronic musicians and audio professionals, for
cash of $79.7 million and stock and stock options with a fair value of $96.5
million. As part of the purchase accounting allocation, we recorded $38.4
million of identifiable intangible assets, consisting of completed technologies,
customer relationships, a trade name and a non-compete covenant. The unamortized
balance of the identifiable intangible assets relating to this acquisition was
$37.9 million at September 30, 2004.
In September 2004, we acquired Avid Nordic AB for cash, net of cash
acquired, of Euro 6.1 million ($7.4 million). As part of the purchase price
allocation we recorded $4.7 million of identifiable intangible assets consisting
solely of customer relationships. The unamortized balance was $4.6 million at
September 30, 2004.
In January 2004, we acquired NXN Software AG, a leading provider of
asset and production management systems specifically targeted for the
entertainment and computer graphics industries, for cash consideration of
(euro)35 million ($43.7 million). As part of the purchase accounting allocation,
we recorded $7.2 million of identifiable intangible assets, consisting of
completed technologies, customer relationships and a trade name. The unamortized
balance of the identifiable intangible assets relating to this acquisition was
$6.3 million at September 30, 2004.
From 2000 to 2003, we recorded intangible assets as we acquired the
following companies or their assets: Rocket Network, Inc. and Bomb Factory
Digital, Inc. in 2003; iKnowledge, Inc. in 2002; iNews, LLC in 2001; and The
Motion Factory, Inc. in 2000. In connection with these acquisitions, we
allocated $7.6 million to identifiable intangible assets consisting of completed
technologies and work force, and $2.2 million to goodwill. As of January 1,
2002, in connection with the adoption of SFAS 142, we reclassified $1.1 million
of a previously recorded assembled work force intangible to goodwill and, as a
result, ceased amortizing this amount. The unamortized balance of the
identifiable intangible assets relating to these acquisitions was $1.2 million
at September 30, 2004.
Included in the operating results for the quarters ended September 30,
2004 and 2003 is amortization for all of these intangible assets of $1.1 million
and $0.3 million, respectively; the nine-month periods ended September 30, 2004
and 2003 include amortization of $2.1 million and $1.0 million, respectively.
The increased levels of amortization primarily reflect the addition of the
M-Audio assets acquired in August 2004 and the NXN assets acquired in January
2004.
Other Income, Net
Other income, net generally consists of interest income and interest
expense. Other income (expense), net for the third quarter of 2004 increased
$0.1 million to $0.7 million compared to $0.6 million for the third quarter of
2003. The increase was primarily due to higher interest income, partially off by
higher interest expense in the 2004 period. For the nine-month period ended
September 30, 2004, other income, net decreased $0.6 million, from $1.3 million
to $0.7 million, as compared to the same period in 2003. The decrease was
primarily due to a charge in the first quarter of 2004 of $1.1 million related
to reaching a pending settlement of a lawsuit, partially offset by higher
interest income earned on higher average cash, cash equivalents, and marketable
securities balances.
Provision for Income Taxes
We recorded a net tax benefit of approximately $(0.1) million, and a
tax provision of $0.3 million for the quarters ended September 30, 2004 and
2003, respectively. The net tax benefit for the quarter ended September 30, 2004
includes an adjustment for refunds of approximately $0.2 million of taxes
previously paid in Canada. Other than this refund, the tax provision for all
17
periods presented was substantially comprised of taxes payable by our foreign
subsidiaries with only alternative minimum tax provided on anticipated U.S.
taxable profits.
The tax provisions for the nine-month periods ending September 30, 2004
and 2003 were $0.1 million and $0.9 million, respectively. The lower tax
provision in the first nine months of 2004 reflects a first-quarter reversal of
a $1.2 million tax reserve resulting from the expiration of the statute of
limitation on that reserve item and the third-quarter above mentioned refund.
Other than these adjustments, the tax provision for all periods presented was
substantially comprised of taxes payable by our foreign subsidiaries with only
alternative minimum tax provided on anticipated U.S. taxable profits.
The tax provision in each quarter is significantly affected by net
changes in the valuation allowance against our deferred tax assets. Regular
federal income taxes resulting from anticipated U.S. profits have been offset by
the utilization of deductions from acquisition-related temporary differences and
net operating loss carry-forwards; the tax provision benefit of utilizing these
items results from the corresponding net reduction in the valuation allowance.
However, due to the remaining level of deferred tax assets and the level of
related historical taxable income, we have determined that the uncertainty
regarding the realization of these remaining assets is sufficient to warrant the
continued establishment of a valuation allowance against nearly all of our
deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date through both private and public
sales of equity securities, including stock option exercises from our employee
stock plans, as well as through cash flows from operations. As of September 30,
2004, our principal sources of liquidity included cash, cash equivalents and
marketable securities totaling $120.1 million.
With respect to cash flow, net cash provided by operating activities
was $57.1 million for the nine months ended September 30, 2004 compared to $40.7
million for the same period in 2003. During the nine months ended September 30,
2004, net cash provided by operating activities primarily reflects net income
adjusted for depreciation and amortization as well as increases in accounts
receivable, accounts payable and deferred revenue. During the nine months ended
September 30, 2003, net cash provided by operating activities primarily reflects
net income adjusted for depreciation and amortization as well as an increase in
deferred revenue and a decrease in accounts receivable, partially offset by a
decrease in accounts payable.
At September 30, 2004 and December 31, 2003, we held inventory in the
amounts of $54.9 million and $38.3 million, respectively. These balances include
stockroom, spares, and demonstration equipment inventories at various locations,
and inventory at customer sites related to shipments for which we have not yet
recognized revenue. The increase in the current quarter reflects primarily the
acquisitions of M-Audio and Avid Nordic AB. We review all inventory balances
regularly for excess quantities or potential obsolescence and make appropriate
adjustments to write-down the inventories to reflect their estimated realizable
value.
Accounts receivable increased by $25.2 million to $94.4 million at
September 30, 2004 from $69.2 million at December 31, 2003, driven primarily by
the year-over-year increase in net revenues but also to the acquisition of
M-Audio. These balances are net of allowances for sales returns, bad debts and
customer rebates, all of which we estimate and record based on historical
experience. Days sales outstanding in accounts receivable increased from 49 days
at December 31, 2003 to 58 days at September 30, 2004. The increase in days
sales outstanding is primarily attributable to the timing of shipments during
the quarter and an increase in deferred maintenance contract billings for which
revenue is recognized ratably in future quarters.
Net cash flow used in investing activities was $129.8 million for the
nine-month period ending September 30, 2004 compared to $53.1 million for the
same period in 2003. During the nine-month period ended September 30, 2004, we
paid cash of $134.2 million for the purchases of NXN, M-Audio and Avid Nordic
AB, net of cash acquired. Also, a payment of $1.0 million for our 2003
acquisition of Bomb Factory Digital was made in early 2004, after resolution of
acquisition-related contingencies, with the final payments totaling $0.4 million
due through December 2004. We purchased $9.8 million of property and equipment
during the nine months ended September 30, 2004 compared to $4.6 million in the
same period of 2003. Purchases of property and equipment in both 2004 and 2003
were primarily of computer hardware and software to support research and
development activities and our information systems. Our full year capital
spending for 2004 is currently expected to be about $12.0 million, including
purchases of hardware and software to support activities in the research and
development, information systems and manufacturing areas, as well as for
facilities renovations.
18
During the nine months ended September 30, 2004 and 2003, we generated
cash of $13.2 million and $44.9 million, respectively, from the issuance of
common stock related to the exercise of stock options and our employee stock
purchase plan.
In connection with restructuring efforts during 2001 and prior periods,
as well as with the identification in 2003 and 2002 of excess space in various
locations, we also have cash obligations of approximately $15.4 million under
leases for which we have vacated the underlying facilities. We have an
associated restructuring accrual of $3.8 million at September 30, 2004
representing the excess of our lease commitments on space no longer used by us
over expected payments to be received on subleases of such facilities. These
payments will be made over the remaining terms of the leases, which have varying
expiration dates through 2010, unless we are able to negotiate an earlier
termination. All restructuring related payments will be funded through working
capital.
Our cash requirements vary depending upon factors such as our planned
growth, capital expenditures, the possible acquisition of businesses or
technologies complementary to our business and obligations under past
restructuring programs. We believe our existing cash, cash equivalents,
marketable securities and funds generated from operations will be sufficient to
meet our operating cash requirements for at least the next twelve months. In the
event we require additional financing, we believe that we will be able to obtain
such financing; however, there can be no assurance that we would be successful
in doing so, or that we could do so on favorable terms.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 150, "Accounting For Certain Financial Instruments with
Characteristics of Both Liabilities and Equity", which establishes standards for
how an issuer of financial instruments classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances) if, at inception, the monetary
value of the obligation is based solely or predominantly on a fixed monetary
amount known at inception, variations in something other than the fair value of
the issuer's equity shares or variations inversely related to changes in the
fair value of the issuer's equity shares. This Statement is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. On November 7, 2003, the FASB deferred the classification and
measurement provisions of SFAS No. 150 as they apply to certain mandatory
redeemable non-controlling interests. This deferral is expected to remain in
effect while these provisions are further evaluated by the FASB. The Company has
not entered into or modified any financial instruments covered by this statement
after May 31, 2003 and the application of this standard is not expected to have
a material impact on the Company's financial position or results of operations.
On October 13, 2004, the FASB concluded that Statement of Financial
Accounting Standards No. 123R, "Share-Based Payment" ("Statement 123R"), which
would require all companies to measure compensation cost for all share-based
payments (including employee stock options) at fair value, would be effective
for public companies (except small business issuer as defined in SEC Regulation
S-B) for interim or annual periods beginning after June 15, 2005. Retroactive
application of the requirements of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation," ("Statement 123"), not
Statement 123R, to the beginning of the fiscal year that includes the effective
date would be permitted, but not required. Note 5 - "Accounting for Stock Based
compensation" sets forth the pro forma effect on net income and earnings per
share assuming Avid had applied the fair value recognition provisions of
Statement 123. The retroactive provisions permitted under this conclusion will
not impact Avid since the first interim period that Statement 123R will be
effective for Avid will be the third quarter of 2005.
19
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
Some of the statements in this Form 10-Q relating to our future
performance constitute forward-looking statements. Such forward-looking
statements are based upon management's current expectations and involve known
and unknown risks. Realization of any of these risks may cause actual results to
differ materially from the results described in the forward-looking statements.
Certain of these risks are as follows:
Our performance will depend in part on continued market acceptance of our new
digital nonlinear editing products.
We recently introduced several new digital non-linear products based on
our Digital Nonlinear Accelerator architecture, including our next-generation
Media Composer (Media Composer Adrenaline) and NewsCutter (NewsCutter
Adrenaline) systems, as well as Avid Xpress Pro with Avid Mojo and Avid DS
Nitris hardware. We will need to continue to focus marketing and sales efforts
on educating potential customers and our resellers about the uses and benefits
of these products. The future success of certain of these products, such as Avid
DS Nitris, which enable high-definition production, will also depend on consumer
demand for appliances, such as television sets and monitors, that utilize the
high definition standard. In addition, there are several other risks involved
with offering new products in general, including, without limitation, the
possibility of defects or errors, failure to meet customer expectations, delays
in shipping new products and the introduction of similar products by our
competitors. At the same time, the introduction and transition to new products
could have a negative impact on the market for our existing products, which
could adversely affect our revenues and business.
The broadcast market is large, widely dispersed, and highly competitive, and we
may not be successful in growing our customer base or predicting customer demand
in this market.
We are currently building our presence in the digital broadcast market
and have augmented our NewsCutter product offering with the Avid Unity for News
products, and the server, newsroom, and browser products obtained in the Pluto
and iNews acquisitions. The broadcast market is distinguished from our
traditional video business in that turnkey, fully integrated, complex solutions
(including the configuration of unique workflows), rather than discrete point
products, are frequently required by the customer. Success in this market will
require, among other things, creating compelling solutions and developing a
strong, loyal customer base.
In addition, large, complex broadcast orders often require us to devote
significant sales, engineering, manufacturing, installation, and support
resources to ensure their successful and timely fulfillment. As the broadcast
market converts from analog to digital, our strategy has been to build our
broadcast solutions team in response to customer demand. To the extent that
customer demand for our broadcast solutions exceeds our expectations, we may
encounter difficulties in the short run meeting our customers' needs. Meanwhile,
our competitors may devote greater resources to the broadcast market than we do,
or may be able to leverage their market presence more effectively. If we are
unsuccessful in capturing and maintaining a share of this digital broadcast
market or in predicting and satisfying customer demand, our business and
revenues could be adversely affected.
Our revenues are becoming increasingly dependent on sales of large, complex
solutions.
We expect sales of large, complex solutions to continue to constitute a
material portion of our net revenue, particularly as news stations convert from
analog, or tape-based, processes to digital formats. Our quarterly and annual
revenues could fluctuate significantly if:
o sales to one or more of our customers are delayed or are not completed
within a given quarter;
o the contract terms preclude us from recognizing revenue during that quarter;
o news stations' migrations from analog processes to digital formats slows
down;
o we are unable to complete complex customer installations on schedule;
o our customers reduce their capital investments in our products in response
to slowing economic growth; and
o any of our large customers terminate their relationship with us or
significantly reduce the amount of business they do with us.
20
Our products are complex, and may contain errors or defects resulting from such
complexity.
As we continue to expand our product offerings to include not only point
products but also end-to-end solutions, our products have grown increasingly
complex and, despite extensive testing and quality control, may contain errors
or defects. Such errors or defects could cause us to issue corrective releases
and could result in loss of revenues, delay of revenue recognition, increased
product returns, lack of market acceptance, and damage to our reputation.
The markets for our products are competitive, and we expect competition to
intensify in the future.
The digital video, audio, and 3D markets are highly competitive, with
limited barriers to entry, and are characterized by pressure to reduce prices,
incorporate new features, and accelerate the release of new products. Some of
our current and potential competitors have substantially greater financial,
technical, distribution, support, and marketing resources than we do. Such
competitors may use these resources to lower their product costs, allowing them
to reduce prices to levels at which we could not operate profitably. Delays or
difficulties in product development and introduction may also harm our business.
If we are unable to compete effectively in our target markets, our business and
results of operations could suffer.
In addition to price, our products must also compete favorably with our
competitors' products in terms of reliability, performance, ease of use, range
of features, product enhancements, reputation and training.
New product announcements by our competitors and by us also could have
the effect of reducing customer demand for our existing products. New product
introductions also require us to devote time and resources to training our sales
channels in product features and target customers, with the temporary result
that the sales channels have less time to devote to selling our products.
We have a significant share of the professional audio market, and therefore
growth in this market will depend in part on our ability to successfully
introduce new products or expand into new distribution channels.
Products from our Digidesign division have captured a significant
portion of the professional audio market, due in large part to a series of
successful product introductions. Our future success will depend in part upon
our ability to offer, on a timely and cost-effective basis, new audio products
and enhancements of our existing audio products. This can be a complex and
uncertain process, and we could experience design, manufacturing, marketing, or
other difficulties that delay or prevent the introduction of new or enhanced
products, or the integration of acquired products, which, in turn, could harm
our business.
At M-Audio, revenue has historically been derived from sales through
the same or similar channels as Digidesign. However, M-Audio is currently
expanding its sales channel to include sales through the broader consumer market
channel. While we are not anticipating that a significant portion of our
revenues will come through this channel in the near term, our overall experience
addressing the consumer market channel is limited, and there are some costs
related to pursuing the consumer market channel which are, to a certain extent,
fixed. As a result, we may be unable to adjust our spending in a timely manner
to compensate for any unexpected revenue shortfall from this channel, which
could harm our operating results.
When we acquire other companies or businesses, we become subject to risks that
could hurt our business.
We periodically acquire businesses and form strategic alliances. For
example, and in January 2004, we acquired NXN Software AG, a company that
manufactures asset and production management systems specifically targeted for
the entertainment and computer graphics industries, and in August 2004, we
acquired Midiman, Inc. (d/b/a M-Audio), a leading provider of digital audio and
MIDI solutions for electronic musicians and audio professionals. The risks
associated with such acquisitions, alliances, and investments include, among
others:
o the difficulty of assimilating the operations, policies and personnel of the
target companies;
o the failure to realize anticipated returns on investment, cost savings and
synergies;
o the diversion of management's time and attention;
o the dilution existing stockholders may experience if we decide to issue
shares of our common stock or other rights to purchase our common stock as
consideration in the acquisition in lieu of cash;
o the potential loss of key employees of the target company;
21
o the difficulty in complying with a variety of foreign laws;
o the impairment of relationships with customers or suppliers of the target
company or our customers or suppliers; and
o unidentified issues not
discovered in our due diligence process, including product quality issues
and legal contingencies.
Such acquisitions, alliances, and investments often involve significant
transaction-related costs and could cause short-term disruption to normal
operations. In the future we may also make debt or equity investments. If we are
unable to overcome or counter these risks, it could undermine our business and
lower our operating results.
Our use of independent firms and contractors to perform some of our product
development and manufacturing activities could expose us to risks that could
adversely impact our revenues.
Independent firms and contractors, some of whom are located in other
countries, perform some of our product development and manufacturing activities.
We generally own the software developed by these contractors. The use of
independent firms and contractors, especially those located abroad, could expose
us to risks related to governmental regulation (including tax regulation),
intellectual property ownership and rights, exchange rate fluctuation, political
instability and unrest, natural disasters, and other risks, which could
adversely impact our revenues.
An interruption of our supply of certain products or key components from our
sole source suppliers, or a price increase in such products or components, could
hurt our business.
We are dependent on a number of specific suppliers for certain products
and key components of our products. We purchase these sole source products and
components pursuant to purchase orders placed from time to time. We generally do
not carry significant inventories of these sole source products and components
and have no guaranteed supply arrangements. If any of our sole source vendors
should fail to produce such products or to supply or enhance such components, it
could imperil our supply and our ability to continue selling and servicing
products that use these components. Similarly, if any of our sole source vendors
should encounter technical, operating or financial difficulties, it could
threaten our supply of these products or components. While we believe that
alternative sources for these products and components could be developed, or our
products could be redesigned to permit the use of alternative components, an
interruption of our supply could damage our business and negatively affect our
operating results.
Our gross profit margin varies from product to product depending
primarily on the proportion and cost of third-party hardware included in each
product. From time to time, we add functionality and features to our products.
If we effect such additions through the use of more, or more costly, third-party
hardware, and are not able to increase the price of such products to offset
these increased costs, our gross profit margin on these products could decrease
and our operating results could be adversely affected.
Qualifying and supporting our products on multiple computer platforms is time
consuming and expensive.
Our software engineers devote significant time and effort to qualify and
support our products on various computer platforms, including most notably,
Microsoft and Apple platforms. Computer platform modifications and upgrades
require additional time to be spent to ensure that our products will function
properly. To the extent that the current configuration of the qualified and
supported platforms changes or we need to qualify and support new platforms, we
could be required to expend valuable engineering resources, which could
adversely affect our operating results.
Our operating results are dependent on several unpredictable factors.
The revenue and gross profit from our products depend on many factors,
including:
o mix of products sold;
o cost and proportion of third-party hardware included in such products;
o product distribution channels;
o acceptance of our new product introductions;
o product offers and platform upgrades;
o price discounts and sales promotion programs;
o volume of sales of aftermarket hardware products;
o costs of swapping or fixing products released to the market with defects;
22
o provisions for inventory obsolescence;
o competitive pressure on product prices;
o costs incurred in connection with "solution" sales, which typically have
longer selling and implementation cycles; and
o timing of delivery of "solutions" to customers.
Changes in any of these factors could affect our operating results.
Our operating results could be harmed by currency fluctuations.
We generally derive nearly half of our revenues from customers outside
of the United States. This business is, for the most part, transacted through
international subsidiaries and generally in the currency of the end-user
customers. Therefore, we are exposed to the risks that changes in foreign
currency could adversely impact our revenues, net income (loss), and cash flow.
To hedge against the foreign exchange exposure of certain forecasted
receivables, payables and cash balances of our foreign subsidiaries, we enter
into foreign currency forward-exchange contracts. We record gains, and losses
associated with currency rate exchanges on these contracts in results of
operations, offsetting gains and losses on the related assets and liabilities.
The success of this hedging program depends on forecasts of transaction activity
in the various currencies. To the extent that these forecasts are over- or
understated during the periods of currency volatility, we could experience
currency gains or losses.
Our operating costs are tied to projections of future revenues, which may differ
from actual results.
Our operating expense levels are based, in part, on our expectations of
future revenues. Such future revenues are difficult to predict. A significant
portion of our business occurs near the end of each quarter, which can impact
our ability to precisely forecast revenues on a quarterly basis. Further, we are
generally unable to reduce quarterly operating expense levels rapidly in the
event that quarterly revenue levels fail to meet internal expectations.
Therefore, if quarterly revenue levels fail to meet internal expectations upon
which expense levels are based, our results of operations could be adversely
affected.
Poor global macroeconomic conditions could disproportionately impact our
industry.
In recent years, our customers in the media, broadcast and
content-creation industries delayed or reduced their expenditures in part
because of unsettled economic conditions. The revenue growth and profitability
of our business depends primarily on the overall demand for our products. If
global economic conditions worsen, demand for our products may weaken, and our
business and results of operations could suffer.
Terrorism, acts of war, and other catastrophic events may seriously harm our
business.
Terrorism, acts of war, or other catastrophic events may disrupt our
business and harm our employees, facilities, suppliers, distributors, resellers
or customers, which could significantly impact our revenue and operating
results. The increasing presence of these threats has created many economic and
political uncertainties that could adversely affect our business and stock price
in ways that cannot be predicted. We are predominantly uninsured for losses and
interruptions caused by terrorism, acts of war, and other conflicts and events.
If we fail to maintain strong relationships with our resellers, distributors,
and suppliers, our ability to successfully deploy our products may be harmed.
We sell many of our video products and services, and substantially all
of our audio products and services, indirectly through resellers and
distributors. The loss of one or more key distributors could reduce our
revenues. The resellers and distributors of our video segment products typically
purchase Avid software and Avid-specific hardware from us, and third-party
components from various other vendors, in order to produce complete systems for
resale. Any disruption to our resellers and distributors, or their third-party
suppliers, could reduce our revenues. Increasingly, we are distributing our
products directly, which could put us in competition with our resellers and
distributors and could adversely affect our revenues. In addition, our resellers
could diversify the manufacturers from whom they purchase products to sell to
the final end-users, which could lead to a weakening of our relationships with
our resellers and could adversely affect our revenues.
23
Most of the resellers and distributors of our video products are not
granted rights to return products after purchase, and actual product returns
from such resellers and distributors have been insignificant to date. However,
our revenue from sales of audio products is generally derived from transactions
with distributors and authorized resellers that typically allow limited rights
of return, inventory stock rotation and price protection. Accordingly, reserves
for estimated returns, exchanges and credits for price protection are provided,
as a reduction of revenues, upon shipment of the related products to such
distributors and resellers, based upon our historical experience. To date,
actual returns have not differed materially from management's estimates.
However, if returns of our audio segment products were to exceed estimated
levels, our revenues and operating results could be adversely impacted.
Our future growth could be harmed if we lose the services of our key personnel.
Our success depends upon the services of a number of key employees
including members of our executive team and those in certain technical
positions. The loss of the services of one or more of these key employees could
harm our business. Our success also depends upon our ability to attract highly
skilled new employees. Competition for such employees is intense in the
industries and geographic areas in which we operate. In the past, we have relied
on our ability to grant stock options as one mechanism for recruiting and
retaining highly skilled talent. Recent proposed accounting regulations
requiring the expensing of stock options may impair our future ability to
provide these incentives without incurring significant compensation costs. If we
are unable to compete successfully for our key employees, our business could
suffer.
Our websites could subject us to legal claims that could harm our business.
Some of our websites provide interactive information and services to our
customers. To the extent that materials may be posted on and/or downloaded from
these websites and distributed to others, we may be subject to claims for
defamation, negligence, copyright or trademark infringement, personal injury, or
other theories of liability based on the nature, content, publication or
distribution of such materials. In addition, although we have attempted to limit
our exposure by contract, we may also be subject to claims for indemnification
by end users in the event that the security of our websites is compromised. As
these websites are available on a worldwide basis, they could potentially be
subject to a wide variety of international laws.
Regulations could be enacted that restrict our Internet initiatives.
Federal, state, and international authorities may adopt new laws and
regulations governing the Internet, including laws and regulations covering
issues such as privacy, distribution, and content. For example, the European
Union has issued several directives regarding privacy and data protection,
including the Directive on Data Protection and the Directive on Privacy and
Electronic Communications. The enactment of legislation implementing such
directives by member countries is ongoing. The enactment of this and similar
legislation or regulations could impede the growth of the Internet, harm our
Internet initiatives, require changes in our sales and marketing practices and
place additional financial burdens on our business.
We could incur substantial costs protecting our intellectual property or
defending against a claim of infringement.
Our ability to compete successfully and achieve future revenue growth
depends, in part, on our ability to protect our proprietary technology and
operate without infringing upon the intellectual property rights of others. We
rely upon a combination of patent, copyright, trademark and trade secret laws,
confidentiality procedures, and contractual provisions, as well as required
hardware components and hardware security keys, to protect our proprietary
technology. However, our means of protecting our proprietary rights may not be
adequate. In addition, the laws of certain countries do not protect our
proprietary technology to the same extent as do the laws of the United States.
From time to time unauthorized parties have obtained, copied, and used
information that we consider proprietary. Policing the unauthorized use of our
proprietary technology is costly and time-consuming and we are unable to measure
the extent to which piracy of our software exists. We expect software piracy to
be a persistent problem.
We occasionally receive communications suggesting that our products may
infringe the intellectual property rights of others. It is our practice to
investigate the factual basis of such communications and negotiate licenses
where appropriate. While it may be necessary or desirable in the future to
obtain licenses relating to one or more products or relating to current or
future technologies, we may be unable to do so on commercially reasonable terms.
24
If we are unable to protect our proprietary technology or unable to negotiate
licenses for the use of others' intellectual property, our business could be
impaired.
We are currently involved in various legal proceedings, including
patent litigation. An adverse resolution of any such proceedings could harm our
business and reduce our results of operations. See Note I, "Commitments and
Contingencies" in our audited financial statements filed on Form 10-K.
Our association with industry organizations could subject us to litigation.
We are members of several industry organizations, trade associations
and standards consortia. Membership in these and similar groups could subject us
to litigation as a result of the group's activities. For example, in connection
with our anti-piracy program, designed to enforce copyright protection of our
software, we are a member of the Business Software Alliance (BSA). From time to
time the BSA undertakes litigation against suspected copyright infringers. These
lawsuits could lead to counterclaims alleging improper use of litigation or
violation of other local law. To date, none of these law suits or counterclaims
have had an adverse effect on our results of operations, but should we become
involved in material litigation, our cash flows or financial position could be
adversely effected.
The Sarbanes-Oxley Act of 2002 has caused our operating expenses to increase and
has put additional demands on our management.
The Sarbanes-Oxley Act of 2002 and newly enacted rules and regulations
of the Securities and Exchange Commission and the NASDAQ stock market impose new
duties on us and our executives, directors, attorneys and independent auditors.
In order to comply with the new legislation, we have had to hire additional
personnel and use additional outside legal, accounting and advisory services.
These actions have increased our operating expenses. In addition, the new
legislation has made some corporate actions more challenging, such as proposing
new or amendments to stock option plans, which now require stockholder approval,
or obtaining affordable director and officer liability insurance. The added
demands imposed by the new legislation may also make it more difficult for us to
attract and retain qualified executive officers, key personnel and members of
our board of directors.
If we experience problems with our third-party leasing program, our revenues
could be adversely impacted.
We have an established leasing program with a third party that allows
certain of our customers who choose to do so to finance their purchases. If this
program ended abruptly or unexpectedly, some of our customers might be unable to
purchase our products unless or until they were able to arrange for alternative
financing, and this could adversely impact our revenues.
Our stock price may continue to be volatile.
The market price of our common stock has experienced volatility in the
past and could continue to fluctuate substantially in the future based upon a
number of factors, most of which are beyond our control. These factors include:
o changes in our quarterly operating results;
o shortfalls in revenues or earnings compared to securities analysts'
expectations;
o changes in analysts' recommendations or projections;
o fluctuations in investors' perceptions of us or our competitors;
o shifts in the markets for our products;
o development and marketing of products by our competitors;
o changes in our relationships with suppliers, distributors, resellers, system
integrators, or customers; and
o global macroeconomic conditions.
Further, the stock market has experienced volatility with respect to the price
of equity securities of high technology companies generally, and this volatility
has, at times, appeared to be unrelated to or disproportionate to any of the
factors above.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market Risk
Our primary exposures to market risk are financial, including the
effect of volatility in currencies on asset and liability positions and revenue
and operating expenses of our international subsidiaries that are denominated in
foreign currencies, and the effect of fluctuations in interest rates earned on
our cash equivalents and marketable securities.
Foreign Currency Exchange Risk
We generally derive nearly half of our revenues from customers outside
the United States. This business is, for the most part, transacted through
international subsidiaries and generally in the currency of the end-user
customers. Therefore, we are exposed to the risks that changes in foreign
currency could adversely impact our revenues, net income (loss) and cash flow.
To hedge against the foreign exchange exposure of certain forecasted
receivables, payables and cash balances of our foreign subsidiaries, we enter
into short-term foreign currency forward-exchange contracts. There are two
objectives of our foreign currency forward-exchange contract program: (1) to
offset any foreign exchange currency risk associated with cash receipts expected
to be received from our customers over the next 30 day period and (2) to offset
the impact of foreign currency exchange on the Company's net monetary assets
denominated in currencies other than the U.S. dollar. These forward-exchange
contracts typically mature within 30 days of purchase. We record gains and
losses associated with currency rate changes on these contracts in results of
operations, offsetting gains and losses on the related assets and liabilities.
The success of this hedging program depends on forecasts of transaction activity
in the various currencies. To the extent that these forecasts are over- or
understated during the periods of currency volatility, we could experience
unanticipated currency gains or losses.
For the three- and nine-month periods ended September 30, 2004, net
losses resulting from forward-exchange contracts of $0.8 million and $0.7
million, respectively, were included in results of operations, offset by net
transaction and re-measurement gains on the related asset and liabilities of
$0.6 million for the three-month period ended September 30, 2004 and net losses
on the related asset and liabilities of $0.7 million for the nine-month period
ended September 30, 2004. A hypothetical 10% change in foreign currency rates
would not have a material impact on our results of operations, assuming the
above-mentioned forecast of foreign currency exposure is accurate, because the
impact on the forward contracts as a result of a 10% change would at least
partially offset the impact on the asset and liability positions of our foreign
subsidiaries.
Interest Rate Risk
At September 30, 2004, we held $120.1 million in cash, cash equivalents
and marketable securities, including short-term U.S. and Canadian government and
government agency obligations. Marketable securities are classified as
"available for sale" and are recorded on the balance sheet at market value, with
any unrealized gain or loss recorded in other comprehensive income (loss). A
hypothetical 10% increase or decrease in interest rates would not have a
material impact on the fair market value of these instruments due to their short
maturity.
26
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Controls and Procedures. Our management, with the participation of
our Chief Executive Officer and Chief Financial Officer, evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2004. In
designing and evaluating our disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving their objectives,
and management necessarily applied its judgment in evaluating the cost-benefit
relationships of possible controls and procedures. Based on this evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that, as of
September 30, 2004, our disclosure controls and procedures were (1) designed to
ensure that material information relating to us, including our consolidated
subsidiaries, is made known to our Chief Executive Officer and Chief Financial
Officer by others within those entities, particularly during the period in which
this report was being prepared and (2) effective, in that they provide
reasonable assurance that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms.
No change in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended September 30, 2004 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On March 11, 1996, Avid was named as a defendant in a patent infringement suit
filed in the United States District Court for the Western District of Texas by
Combined Logic Company, a California partnership located in Beverly Hills,
California. On May 16, 1996, upon Avid's motion, the suit was transferred to the
United States District Court for the Southern District of New York. The
complaint alleges infringement by Avid of U.S. patent number 4,258,385, and
seeks injunctive relief, treble damages, costs, and attorneys' fees. This patent
expired on May 15, 1999 and therefore, would not be applicable to the products
currently offered by Avid. Accordingly, potential damages, if any, are limited
to the period beginning March 11, 1990 (six years prior to this date of the
complaint) and ending May 15, 1999. In its answer to the complaint, the Company
asserted that it did not infringe the patent and that the patent is invalid.
Avid argued a Motion to Dismiss this claim on November 5, 2004 and is awaiting
the decision of the court. The Company is unable to quantify a range of loss in
this litigation. Combined Logic Company did not specify an alleged damage amount
in its complaint. As only limited discovery has been conducted to date by either
side in the eight years since Combined Logic Company filed its complaint, the
Company believes it does not have sufficient information to provide any
meaningful estimate of the possible range of damages that Combined Logic Company
might seek. The Company believes it has meritorious defenses to the complaint
and intends to contest it vigorously. However, an adverse resolution of this
litigation could have an adverse effect on the Company's consolidated financial
position or results of operations in the period in which the litigation is
resolved. No costs have been accrued for this possible loss contingency.
In March 1999, Avid and Tektronix, Inc. were sued by Glen Holly Entertainment,
Inc., a Tektronix distributor, claiming that Tektronix's discontinuance of the
Tektronix Lightworks product line was the result of a strategic alliance by
Tektronix and Avid. Glen Holly raised antitrust and common law claims against
Avid and Tektronix, and sought lost future profits, treble damages, attorneys'
fees, and interest. In March 2001, the United States District Court for the
District of California dismissed the anti-trust claims against both parties and
the remaining common law claim against the Company was dismissed by stipulation
and court order on April 6, 2001. Glen Holly subsequently appealed the lower
court's decision. On September 9, 2003, a three-judge panel of the U.S. Court of
Appeals for the Ninth Circuit reversed in part the lower court's dismissal and
sent the antitrust claims back to the lower court for further findings. Avid and
Tektronix filed a Petition for a rehearing by the three-judge panel and a
rehearing by the full Ninth Circuit on September 23, 2003. The Petition was
denied on December 12, 2003. On March 18, 2004, the Company entered into a
settlement agreement with Glen Holly whereby each party issued a general release
of all claims relating to the allegations made in this lawsuit. In consideration
of the settlement, Avid agreed to make a payment to Glen Holly of $1,050,000 and
accordingly, $985,000 was paid in March 2004 and the remaining $65,000 was paid
in April 2004. On March 19, 2004, Avid filed an application for determination of
good faith settlement with the U.S. District Court requesting that it determine
whether Tektronix had a right to contribution or indemnification from Avid
arising from claims asserted in the lawsuit. On June 17, 2004, the U.S. District
Court issued a ruling in which it determined that Tektronix had no such right.
On June 24, 2004, Glen Holly filed a stipulation of dismissal with the Court,
dismissing all claims alleged against the Company in this proceeding. On July
14, 2004, the court issued an order finding that the settlement agreement
between Avid and Glen Holly was entered into in good faith under applicable law.
ITEM 6. EXHIBITS
*10.1 Midiman Inc. 2002 Stock Option/Stock Issuance Plan
*#10.2 Form of Incentive Stock Option Agreement
*#10.3 Form of Nonstatutory Stock Option Agreement
*#10.4 Form of Restricted Stock Agreement
#10.5 1997 Stock Incentive Plan (incorporated by reference to the
Registrant's Proxy Statement as filed with the Commission on April 6,
1998, File No. 000-21174)
*31.1 Certification of Principal Executive Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
28
*31.2 Certification of Principal Financial Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
- ---------------------
* Documents filed herewith
# Management contract or compensatory plan
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Avid Technology, Inc.
Date: November 9, 2004 By: /s/ Paul J. Milbury
-----------------------
Paul J. Milbury
Chief Financial Officer
(Principal Financial Officer)
Date: November 9, 2004 By: /s/ Carol L. Reid
-------------------------
Carol L. Reid
Vice President and Corporate Controller
(Principal Accounting Officer)
30
EXHIBIT INDEX
Exhibit No. Description
- ---------- -----------
*10.1 Midiman Inc. 2002 Stock Option/Stock Issuance Plan
*#10.2 Form of Incentive Stock Option Agreement
*#10.3 Form of Nonstatutory Stock Option Agreement
*#10.4 Form of Restricted Stock Agreement
#10.5 1997 Stock Incentive Plan (incorporated by reference to the
Registrant's Proxy Statement as filed with the Commission on April 6,
1998, File No. 000-21174)
*31.1 Certification of Principal Executive Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*31.2 Certification of Principal Financial Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
- ---------------------
* Documents filed herewith
# Management contract or compensatory plan
31